Some quick notes on monetary policy this afternoon:
1.) Another policymaker in favor of a first half rate hike. Cleveland Federal Reserve President Loretta Mester supports a rate hike by June. Via Michael Derby at the Wall Street Journal:
Expressing confidence weak inflation will eventually rise again, Federal Reserve Bank of Cleveland President Loretta Mester said Wednesday the U.S. central bank remains on track for raising rates in the next few months.
Noting that Fed policy isn’t on a “pre-set path,” Ms. Mester said “if incoming economic information supports my forecast, I would be comfortable with liftoff in the first half of this year.” Because Fed policy actions affect the economy over a long period of time, the central banker said the Fed will need to act before it has fully achieved its job and price mandates.
She is, however, watching the survey data:
The official told reporters after her speech that if inflation expectations began to weaken, especially ones derived from surveys, “that would give me pause” when it comes to advocating for rate increases.
While the timing of any policy move remains in flux, Mester's basic story is close to consensus: The Fed is looking at putting the economy on a glide path to achieving its mandates, which means moving ahead of those mandates.
2.) But another is pointing out the danger of low inflation. Boston Federal Reserve President Eric Rosengren doesn't speak to the timing of rate hikes, but low inflation is clearly on his mind:
Of course today, after significant labor market improvement, and with the horizon over which inflation will return to its target being uncertain, inflation has taken on a more prominent role in our deliberations.
Currently, an obvious caveat in interpreting the low inflation rate in the U.S. is the supporting role played by the recent decline in energy prices. Oil shocks have been associated with major changes in monetary policy before. The failure to control inflation in the United States during the 1970s, in the presence of an adverse oil supply shock, highlighted a serious dilemma facing monetary policy at that time. Importantly in that case, what might have been a temporary pass-through of oil to non-oil prices turned into a more lasting problem with overall inflation, as wage and price dynamics at that time helped turn increases in oil prices into fairly protracted increases in overall inflation. Former Federal Reserve Board Chairman Volcker is rightfully recognized for taking forceful action to address the situation and ultimately tame inflation in the United States.
Currently, a concern is that central banks are facing the mirror image of the problem in the 1970s. The problem of significantly undershooting inflation – a dynamic which could well keep interest rates at the zero lower bound – is likely to be a key challenge to central bankers in the first two decades of the 21st century. And I would say that as with the oil shock in the 1970s, the current shock has served to accentuate a potential monetary policy pitfall – in this case, the failure to quickly and vigorously address a significant undershooting of inflation targets, potentially leaving economies stagnant at the zero lower bound.
He would support later rather than sooner with regards to the first rate hike.
3.) Fed ready to lower NAIRU? I have argued in the past that if the Fed is faced with ongoing slow wage growth, they would need to reassess their estimates of NAIRU. Cardiff Garcia reminded me:
@TheStalwart @TimDuy Whether/extent to which Fed reverts nat-rate estimates to pre-2010 range is one of 2015's big Qs pic.twitter.com/CKieHx2zRC
— Cardiff Garcia (@CardiffGarcia) February 4, 2015
While David Wessel adds today:
JPMorgan run the Fed's statistical model of the economy and says the NAIRU (which was 5.6%+ through 2013 data) is now down to 5%.
— David Wessel (@davidmwessel) February 5, 2015
Jim O'Sullivan from High Frequency Economics says not yet:
"Hard-to-fill" @NFIB jobs series up to 26 in Jan (+1). Corroborates unempl decline, with no sign of lower #NAIRU pic.twitter.com/DVYGyGV4e6
— Jim O'Sullivan (@osullivanEcon) February 5, 2015
A reduction in the Fed's estimate of the natural rate of unemployment would likely mean a delayed and more gradual path of policy tightening, should of course the Fed ever get the chance to pull off the zero bound. Keep an eye on this issue!
4.) Will the Fed remain "patient" in March? Jon Hilsenrath at the Wall Street Journal says the Fed needs to remove "patient" from the FOMC statement in March if they want to move in June:
The “patient” assurance, Fed chairwoman Janet Yellen has said, means no rate increases for at least two more policy meetings. The next two policy meetings after March are in April and June. If officials think they might raise rates in June, they need to remove “patient” in March to give themselves the option to proceed if economic data justify a move by June.
Interesting - this is a stricter interpretation of "patient" than I had from Yellen's comments. I did not think that "patient" would always mean just two more meetings, only that in December "patient" meant two more meetings. During the last rate hike cycle, the Fed maintained "patient" until March, switched to "measured" in May, and hiked in June. So they hiked the second meeting after the last "patient." Does that meet the definition that Yellen gave in December? I don't know, but I am not sure she meant to imply that "patient" always and forever means no hike for the next two meetings. So I guess we have our first question for the next press conference. At the moment, following the last cycle, I don't think that keeping "patient" means they are taking June off the table.
5.) Employment report watch. Calculated Risk notes that Goldman Sachs cut their forecast for tomorrow's employment report to a 210k gain in nonfarm payrolls and a 5.5% unemployment rate, at the low end of consensus and similar to my forecast. But the January number might be an even bigger crapshoot than usual anyway. Via Bloomberg:
A significant risk to the January payroll print is that the seasonal adjustment may not be properly calibrated. If employers added more seasonal workers than usual based on a firmer assessment of economic conditions, then there may be more layoffs in January. If the seasonal factors do not properly account for this, then a weaker-than-expected payroll gain could result.
And note that one number doesn't make a trend:
Underlying labor market momentum is largely being sustained, as economic growth remains decent, albeit slower than the mid-year hot streak between Q2 and Q3 of 2014. As such, if January employment disappoints, it is probably an anomaly related to seasonal adjustment issues, not a meaningful downshift in the pace of hiring.
The ongoing improvement in consumer attitudes is an encouraging sign that households continue to sense a healthy labor market.
6.) Falling interest rates worldwide. The global push for easier monetary policy continues. China's central bank is now officially in easing mode, while the Danish Central Bank moves deeper into negative territory. The Fed wants to be able to move in the opposite direction, but financial markets are telling them this isn't the time to move off of zero. The Fed will resist - this isn't 2011 when the US economy was much further from reaching its employment mandate than it is today. That said, they eventually had to relent and ease in 1998, so holding steady would be familiar territory (they are not bringing QE back to life yet). But will they worry that easing then helped sustain an asset bubble, a situation they do not want to repeat? Increasingly, the Fed looks to be back in a place they hoped they had left behind - between a rock and a hard place.
And with that we await tomorrow's employment report. Sorry I don't have time to give each of these topics the time they deserve.
